Why should you compare Ulips?

Ulips are complicated products and there is no clear winner in this race. Various plans offer different benefits. A detailed effect of charges on your fund needs to be seen before arriving at a decision.

Kairav Shah

09 Sep 2009

Ulips (Unit linked insurance plan) can
be safely termed as modern day best-sellers in the Life
insurance segment. True to its reputation, these are quite literally
a seller's product rather than a buyer's product. Ulips have been the
favorites of Life insurance agents who have aggressively propagated
this product. So what does a common man do with a plethora of Ulip
plans which are available in the market. How does he come to a
decision whether to buy it or not? Should he just trust the product
the agent is aggressively trying to sell? Or should he do his own
research and decide for himself? How can a common man shortlist his
plans?

We present here main parameters which
one needs to understand to compare with the peer products to arrive
at a decision.

Premium Allocation Charges:
This is one parameter one needs to be alert about as it could be
the main differentiator between a good and a bad Ulip product. These
are basically the distribution charges which go in the agent's
kitty. This charge is primarily the root cause of Ulips being
aggressively marketed. The charges vary to a great extent between
plans, with the bulk of the charges charged in the first year,
declining in the subsequent years. They lie in a wide range of
0%-100% of your first years premium with the average being around
25% for first year. Due to this wide disparity one needs to compare
these charges before arriving at a decision.

While comparing these charges one
should carefully read the documents provided by insurance companies.
Some companies claim to allocate 100% of first years premium towards
guaranteed maturity addition. This is sometimes incorrectly
comprehended as 0% allocation charges.

What this means is at the
end of 15 years you will get a guaranteed addition of
130000(130%*100000). Now discounting this at a modest rate of 6% we
get a present value of 54244.

In short only Rs.54244 out of your
first years premium of Rs.100000 were invested. This means that there
is an unstated charge of 45.75%. Hence we can see that comparison of
these charges is absolutely necessary be it disclosed charges or
unstated as the above example.

Fund Options: Thepremium amount you invested minus the premium allocation charge
is then invested into various funds offered by Insurance companies.
Each fund typically has two components, Equity & Debt with a cap
on the minimum and maximum exposure to the two components. One needs
to compare the different fund options and choose the preferred
exposure to equities & debt based on your goals and age. There
is also an option of free switching between funds for a specific
number of times in a year. The fund options offered under each plan
vary from 3 to 9.

Fund Management Charges:

This fund value then grows/reduces
according to market conditions and performance of the fund. At the
end of every year the balance fund value is then subjected to a fund
management charge which varies typically from 0.5% to 2.25% of fund
value. Hence a need of comparing these charges and deciding the fund
you want to opt for. Higher the equity component of the fund, higher
the probablity of growth & fund manager skills thus the higher
charges.

Minimum/Maximum Term:

Ulips typically have a minimum term of
5 yrs with the upper end being 75. It however makes less sense to
enter this product with a short term horizon. The minimum time to be
in the policy should ideally be15 yrs. This stems from the fact that
Ulips have very high charges in the initial years declining to as low
as 1%-2% in the 4th yr onwards leaving a significant
amount to grow in the funds. Hence one needs to compare the term
being offered and opt for a term of 15 or above to make the most of
this product.

Death Benefit:

The Death benefit is typically

Higher of Sum Assured and Fund
value

Fund value + Sum Assured.

However plans with Fund value+ Sum
Assured are not necessarily the most beneficial as their premium
allocation charges, Policy administration charges could be
significantly higher as compared to policies offering Higher of Sum
assured or fund value benefit thus bringing down the fund value in
the former case. Hence it is necessary to compare two plans with
different benefits in line with their charges.

Maturity Benefit:

In majority of the plans
the maturity benefit is the fund value. In some cases you get a
guaranteed maturity benefit addition. As explained earlier plans with
such options are not necessarily the best buys as it involves high
costs in the initial stages.

Ulips are complicated products and
there is no clear winner in this race. Various plans offer different
benefits. But one needs to understand with each benefit comes a cost.
Now these costs vary across plans and hence a detailed effect of
charges on your fund needs to be seen before arriving at a decision.
These are the primary 5 parameters you should look at before arriving
at a decision. So before buying a Ulip, question yourself about your
needs, your age, your risk taking ability to venture out in equity
funds and then get this dual product of Insurance with Investment.